At Lululemon’s stock peak in the summer of 2011, the yoga- and running-gear maker commanded a market valuation that was 350% higher than rival Under Armour. Today, Under Armour is worth three times Lululemon.
Investors were left scratching their heads Wednesday after Lululemon (LULU) reported another disappointing round of results. Wall Street was particularly perturbed by the company’s gross margin weakness. It slipped to 46.9% in the third quarter from 50.3% a year ago. Lululemon also trimmed profit and sales targets for the full year. Shareholders ignored rosier gross margin comments on the conference call, when executives forecast margins between 49% and 50% in the current quarter and further recovery next year.
What went wrong? Lululemon should be knocking sales targets out of the park. The chain has been opening new stores and aggressively courting male consumers, giving it greater access to new markets and millions of additional customers. The company started as a yoga brand but expanded to the runner’s market and makes clothes meant for more casual outings.
Lululemon also helped popularize the “athleisure” trend that has become so ubiquitous today. People are wearing gear outside the gym—while out running errands or even in nightly social occasions. While this reporter was waiting for his coffee at a Starbucks Wednesday morning, he stood behind a group of six twentysomething women, all of whom were wearing tights.
But with popularity comes copycats. Stars like Kate Hudson and Jessica Simpson have tapped the activewear market with their own labels. Higher-end brands like Tory Burch have also designed their own sports-inspired lines. And Gap (GPS) is placing a big bet on Lululemon’s biggest direct threat, Athleta.
As its market share has slipped, so has the stock. Since Laurent Potdevin took over as Lululemon’s CEO early in 2014, shares have slipped 20%. Over that same period, Under Armour’s (UA) stock has doubled while Nike’s (NKE) has soared 66%.
All those factors are pointing to the question: Is it time for Lululemon to get bought?
Analysts have speculated the company could be a takeover target, though it has been hard to peg an acquirer. Nike and Under Armour have both traditionally sold more apparel and shoes to men, but are trying to address the women’s market as well. Nike’s women’s business stands at $5.7 billion today, and the world’s largest athletic-gear maker expects that figure will grow to over $11 billion. But the Lululemon wave might now jibe well with the Nike swoosh.
“Buying Lululemon would not be a substitute for building a branded women’s business,” wrote Sterne Agee CRT analyst Sam Poser in a note to clients. “Neither Nike or Under Armour can be a true global athletic brand without its own branded women’s business.”
Lululemon also has a much different business model. All the gear it makes is sold at its own stores or on its website. But Nike and Under Armour both have sizable wholesale channels, in addition to their own stores. A company like VF Corp. (VFC) might be a better fit since it already owns a slew of outdoor and athletic brands, including The North Face and Reef.
Any acquirer would likely still need to fix a brand problem that Lululemon hasn’t fully been able to shake. The company was a stock darling in part because of the cult-like popularity of its black leggings and tank tops. But quality issues surfaced in 2013, when it was forced to pull some of its popular pants after a mistake by a supplier left them somewhat see-through. Founder Chip Wilson also found himself in hot water around the time of the recall when he said that the company’s pants weren’t meant to work for all body types.
The quality issues aren’t why margins are pressured today, but they gave competitive brands an opening. The concern now is that Lululemon’s price premium may not carry the cachet it once did. With more options for more affordable gear, it may be too much of a stretch to convince women that they still need to drop $128 for the latest tights.
